25 lines
1.7 KiB
Plaintext
25 lines
1.7 KiB
Plaintext
Implied Volatility
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Volatility is one of the six inputs of an option-pricing model. Some of the
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other inputs—strike price, stock price, the number of days until expiration,
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and the current interest rate—are easily observable. Past dividend policy
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allows an educated guess as to what the dividend input should be. But
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where can volatility be found?
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As discussed in Chapter 2, the output of the pricing model—the option’s
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theoretical value—in practice is not necessarily an output at all. When
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option traders use the pricing model, they commonly substitute the actual
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price at which the option is trading for the theoretical value. A value in the
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middle of the bid-ask spread is often used. The pricing model can be
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considered to be a complex algebra equation in which any variable can be
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solved for. If the theoretical value is known—which it is—it along with the
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five known inputs can be combined to solve for the unknown volatility.
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Implied volatility (IV) is the volatility input in a pricing model that, in
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conjunction with the other inputs, returns the theoretical value of an option
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matching the market price.
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For a specific stock price, a given implied volatility will yield a unique
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option value. Take a stock trading at $44.22 that has the 60-day 45-strike
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call at a theoretical value of $1.10 with an 18 percent implied volatility
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level. If the stock price remains constant, but IV rises to 19 percent, the
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value of the call will rise by its vega, which in this case is about 0.07. The
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new value of the call will be $1.17. Raising IV another point, to 20 percent,
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raises the theoretical value by another $0.07, to $1.24. The question is:
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What would cause implied volatility to change? |